Exchange Rates What are the effects of revaluing the Yuan

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The exchange rate is literally how much a currency costs in terms of another. The exchange rate is used when simply converting one currency to, or for engaging in speculation or trading in the foreign exchange market. There are a wide variety of factors which influence the exchange rate, such as interest rates, inflation, and the state of politics and the economy in each country.

Types of Exchange Rates

Floating Exchange Rates: when the factors of demand and supply affect the foreign exchange market. Capital and Trade movement are the main things affecting the exchange rate.

Fixed Exchange Rate: when the exchange rate is set at a fixed point and the government or central bank flex their muscle to ensure it stays there.

Semi fixed exchange rate: when the value of the currency is allowed to however within a selected region.

The exchange rates are often influenced by a host of macroeconomic variables, inclusive of economic indicators released by governments at fixed intervals. For instance, the Gross Domestic Product (GDP), unemployment rate, and even current interest rates (prime rates) can all affect currency exchange rates. However, it is possible for major political events (such as elections, wars, etc.) to also affect currency exchange rates. Even commodities (gold, oil prices, wheat, etc.) may affect the exchange rates between countries.

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Problem Statement

Recently countries such as The United States of America have been quite outspoken in that they feel the Chinese Yuan is highly undervalued (by at least 30%), thus giving China a huge competitive edge in the global market. This has thus sparked Currency wars or "Economic Devaluation" among many countries as china has so far refused to bend to the pressure with the pace that the Americans would prefer they did by only revaluing the currency by only 2.1%. this has led to greater attempts by the United States to try and get the Yuan revalued. Thus the main problem that arises from this situation is the question of what exactly will happen to the Chinese Economy. What is the effect that it will have on its major trade partners?

A number of studies have been carried out on the particular topic but given the current economic climate after the World Economic Crisis in 2008 it became more interesting to find out what the actual revaluing of the Yuan at a high rate would do to the world economies.

The current driving factors for the US pressure on china to revalue the Yuan come from that during the beginning 9 months of the year 2010 the trade deficit between the two states was $201 billion which was higher than the entire 2009 figure which was $227 thus it had been expected that by the end of year 2010 the figure would have surpassed that of the previous year. The main feeling coming from the United States is that the economy of PRC is growing at the expense of the United States economy because of its low costs advantage in production costs as well as from having such an undervalued currency. In order to maintain their currency low China has pegged it against a basket of goods which contains the dollar at a certain level. China also purchases the buys the dollar whenever it starts depreciating so as to keep it at a desired level. This is the main reason why they are the largest investor in America's treasuries. By the end of 2009 they held US treasury worth around $790 billion (US). The US feels that the trade deficit may be what's causing the high rates of unemployment as domestic production has gone down the drain. The feeling within the US is that a Yuan appreciation will cause the US domestic production to come back to life as the will be more competition and this will reflect well on GDP. Leading economists such as Paul Krugman and Fred Bergsten have concluded that the low rate of the Yuan costs the American economy around $200 million per annum and up to ten million missed job opportunities.

For China they feel that Yuan appreciation may relieve pressure on foreign economies by boosting their exports and reducing trade deficits, but it runs counter to Beijing's domestic priorities, which involve doing everything it can to preserve economic growth and domestic stability. The drop in exports would make marginal factories go out of business causing their workers to be let go. Other companies would move low-wage manufacturing to countries such as Vietnam and Sri Lanka. China also feels that even if they do revalue it won't mean that the results will bode well for the Americans as even though less imports may come to America from China, they may increase from other countries which also produce goods at lower prices.

Objective of Study

Objectives of the Study are.

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Determine what Yuan revaluation will do to the exports , BOP, GDP and growth of china

Determine what Yuan revolution will do to its main trade partners BOP, exports and GDP

Significance of Study

The foreign exchange rate has a profound effect on the country's exports and imports thus it has a huge effect on the trade balance of the nation. With a low exchange rate the country is more competitive thus exports a lot thus more money is coming into the country and less is going out as foreign currencies strengths discourage it.

With China's ever strengthening grip on the world economy many nations have complained that China's low valued Yuan is not fair as its led to the Chinese' economies meteoric rise and inversely to the slump of theirs. This study aims to see whether the massive revaluation of the Yuan will actually lead to China's undoing and if this will actually be in the best interest of these nations e.g. will it reduce the trade deficit that the United States is undergoing. This study also looks to see what this strengthening of the Yuan will do to the Asian economies.

This study will be significant to investors who may be seeking to either continue investing in China or to those looking to start investing there. Economists who have an eye on the economy may also be interested in seeing what the possible effects of revaluation are. Politicians who want to know what such a revaluation will do to the economic climate in the area. Bankers will also have a look at such as it will be highly interesting to them given they deal with exchange rates on a daily bases.

Scope of Study

This study will focus on the impacts of revaluing the Yuan to China and certain Asian economies (Japan ,Korea, Malaysia ,Thailand).

This study is organized as follows: There is Chapter 2 which is literature review. It gives an insight into other authors' perspective of the same topic. Some information is deduced from these past studies to help in enriching the study and determining the conclusion.

Chapter 3 is the methodology part. The section is concerned with developing and applying quantitative and statistical methods to the study. It is divided into several sections such as statistical/econometrics properties, sources of data and estimation techniques.

Chapter 4 presents the data and discusses the empirical results. This idea of the chapter is to present the results from the estimation techniques to be used such as normality test and unit root.

Chapter 5 concludes the study and provides some policy implications.

Literature review

Economic Impact of the Chinese Yuan revaluation

Zhang Xiaohe

The aim of this paper is to try and figure out what effect a possible revaluation of the Yuan will have on the economy of China and on its major trade partners. The author is trying to put two hypotheses to the test, one by Robert Mundell and the other by Joseph Stiglitz. Mundell theory is that by revaluing the Yuan China's growth will fall from 9% to about half that and Stiglitz believes the revaluation will have little impact on the United States and global economies. The authors suggested answer is that the economic impact of said revaluation on China' and its major trade partners America, Japan and Australia will be negative in nature.

What the Author tries to add in this particular research is to try and figure out what measure the Chines can take e.g. expansionary fiscal policies simultaneously with the revaluation to try and nullify the impact of revaluation on production and trade .

The data supplied I felt was inadequate for the tests as not much info was given on trade activities between the other countries which deal with China either than America. Even with the Americans there amount of Data supplied is limited.

So as to tackle what the results of revaluation will be, the author uses the multi-country econometric model (MCU) created by Ray Fair. "With this particular model any switches that occur in single or more exogenous variables in the nation cause a difference between the projected dataset and its original dataset based on the regression of long term historical statistical data (1960) - (2005) for each of the nation's variables." Through running this model the author is able o match up the sets of data and estimate the "net effect" of implementing the policy. The variables were retrieved from 39 countries and are GDP, inflation, consumption, investment, export, import and employment.

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With the 39 nations there were 15 stochastic equations estimated for each nation. There was also 31 stochastic equations for the American model. the entire model contained 365 stochastic equations and 4500 variables. The entire model allows for forecasting of certain policies in the coming years. Two hypothetical scenarios were then applied. One was with the Yuan being appreciated by 20% and the other was with the same percentage of increase in the Yuan but rather with there also being Fiscal Policies implemented to try and soften the blow of this revaluation.

The assumptions made in the models that certain variables affect the economy to certain levels are quite accurate because when the same model was set to calculate the effects of the Yuan revaluation in 2005 it predicted the effects on the economy quite well.

The manner in which the tests and scenarios were explained was quite good but the only disappointment is that the author did not give a graphical representation of the models. The conclusion of the assessment though is that the results prove the Mundell and Stiglitz theories to be correct in that the revaluation of the Yuan would affect the Chinese economy as well as the global economy to some extent. It concludes that the revaluation would not be favorable in terms of choice for China as the results will not be good for its economy as the opposite of inflation would take place and Chinese competitiveness in the global market would fall. Another thing that the tests conclude is that if the appropriate fiscal policies are implemented the effect of revaluation could cause the effect on the economy to be less. The author's conclusion go hand in hand with the tests' results that where presented for the 2 hypothetical situations that where compared.

The authors argument is compelling and given what they have based their argument on pretty convincing. The forecasting used through the Fair model helps justify the authors argument.

Literature Review

The Impact of Yuan Revaluation on the Asian region

Glenn Hoggarth and Hui Tong

The aim of the paper is to understand how the revaluation of the Yuan will affect other Asian countries. The author wants to put the standard thought that the strengthening in the RMB will cause the exports of China to depreciate but those of other nations in the Asian region to increase. The author believes that the increment by the Yuan will have very little or even a negative effect on most Asian nations.

The also wants to extend the research by finding out if the effect will be ambiguous depending on what type of goods the Asian nations produce. Bilateral export and import equations are estimated for 10 countries from Asia: China, Korea, Japan, Singapore, India, Indonesia, Malaysia, Pakistan, Philippines and Thailand. The Bilateral quarterly data on trade flows are attained from the IMF's Direction of Trade Statistics.

The methods undertaken panel data analysis is used in this paper, which pools countries together and increases the sample size significantly. For instance, with 180 countries and 80 quarterly observations, the sample size rises to 10,000. There are three empirical models employed in the research, the first is the Chinese exports, second is the Chinese imports and the third is Non-Chinese exports to third markets.

The assumptions being made are that any changes in the valuation of the Yuan will cause some form of shift on the Exports and Imports of China plus also have an impact on the exports of Non-Chinese exports. The manner in which the models were explained was pretty clear and data was gathered from 1995 - 2004.

The conclusion to the journal was that for countries that supply consumer goods to third party countries and china may have a slight boost in their exports and for those that supply high end good to china there will be a slump in their exports. The author structures his argument well and manages to attain the required info to state his case.

Impact of China Yuan Revaluation

William Pan

This paper was written with the intent of realizing the results of what the revaluation of the Yuan would mean as a result to other countries.

This paper was written during the George Bush administration time, when great pressure was being put on the Chinese to appreciate their currency. The aim of the bush administration was to have the Yuan not pegged onto the USD and this occurred in July 2005. The paper observed the reasons behind this great push by the US to have the Yuan revalued. These reasons stemmed from the great and constantly increasing trade deficit the US had with China.

The paper observes that if China do fall to pressure and continue to appreciate their currency, the Yuan could end up replacing the USD as Asia's dominant trading currency.

This would also lead to a relaxation in the tariffs and etc. that the US imposed on china so as to force China to revalue its currency. Thus the revaluation would reduce tensions between the two countries.

In conclusion the revaluation would create less of a trade deficit between the us and china,this would in turn reduce pressure leveled on the Bush admin by congress to do something about the situation. Other effects would be that China exports would reduce and the Yuan could be wel on its way to replacing the USD as the main currency for trade in Asia. This would also have the effect of slowin down the red hot growth of the Chinese economy.

The Yuan's Exchange Rates and Pass-through Effects on the Prices of Japanese and US Imports

Xing, Yuqing.

This paper studied pass-through effects of the Yuan's revaluation bearing to import prices of the People's Republic of China's major trading partners the United States and Japan. In the US situation, pass-through effects were looked at on general import prices of all goods brought in from China. In Japan issue, the pass through wasn't looked at only on general import prices analyzed, but as well as on various commodity groups.

Definition of pass through : % change in local currency import prices due to a 15 change in exchange rate between importing and exporting countries. As the Yuan has been fluctuating against the Yen for a long time it is much easier to measure this effect and the author wants to extend on his research by comparing the pass through effect between US and Japan, this enables the author to figure out how much the pass-through effects of the yuan's increase in valuation had been exaggerated by currency invoicing and destination markets.

The author believes that the appreciation of the Yuan had no effect on Japanese import prices in the short or long run. The author uses standard mark-up models to analyze the pass through effect.

The data gathered from japan was from 1998 while from the US the main focus was after 2004. The variables used were imports, exports, marginal costs, unit labor costs, PPI, CPI. In the case of Japan, the regression model was estimated for all imports as well as imports in food, raw materials, apparel, manufacturing and machinery. PPI for different sectors was utilized for every single related sector and the periodic time series data coming from 1998 ending 2008

The author clearly explains how the testing takes place and justifies his case well. The testing goes along with the proposed hypothesis. Empirical outcomes show that the pass-through effects of the Yuan's increment on prices of US imports and that of Japan are highly different. While the effects on US import prices are comparatively weak, 23% - short run and less than 47%-long run, the author failed to find evidence that the Yuan's increment from July 2005 to 2008 was passed on to prices of Japanese import from China.

China's Economy after the Currency Revaluation-Policy Management Implications and the Effect on Domestic and Foreign Economies

By: Sayuri Ito

The aim of this paper is to figure out if China can maintain growth after revaluation of the Yuan through a number of economic policies.

The Effects of Revaluating the Yuan on Stock Markets

Geungu Yu

This paper aims to figure out the price attitude of the Standard & Poor's 500index and the Shanghai Stock Exchange index pre and post the Yuan revaluation in 2005. It first looks at the advantages and disadvantages of the revaluation and then concludes on the efficiency of stock markets of both nations. The author's main thought at the beginning is that the revaluation had little effect on the markets. exchange rates of Yuan/USD were gathered from the Fed Stats Release. S&P 500 and SSE data was supplied through Commodity Systems, Inc. The before-revaluation as well as the after-revaluation periods spans 3 years preluding and following July 21, 2005, at which time China formally appreciated the Yuan. For analytical reasons, this research employs that date of 21/7/2005 as the Southwestern Economic Review: Research Notes benchmark to be the border between before increment of Yuan (19/07/2002 through 21/07/2005) and after increment time of the Yuan (July 21, 2005 through July 21, 2008). Since economic and political issues make up the landscape of the goods and bads of the revaluation, the author makes this research to be focused on a qualitative, observationally descriptive, outlook to observe repercussions of the revaluation on the stock markets.

The author doesn't give models or an empirical formula. Thus I feel the number of variables employed were too few to truly make this study significant. What the author found out though is that in the years from july 2002 the S&P outperformed the SSE but after the revaluation the SSE did much better than the S&P. this was shown by how the SSE declined by 40.5% before revaluation but did much better (rising 180.36%) during period after revaluation.

The author concluded that this research finds some connection among yield spread fluctuations and performance of differing styles of investing, this implies that yield spread shifts could be sufficient indications for choosing between growth vs. value stocks. I don't think the author gave enough information to support his argument.

Structural effects of Real Exchange Rate Revaluation on China

Dirk Willenbockel

The paper aims to see what a significant appreciation in China's Yuan would do to the economic structure of the nation. This will be done by simulating the revaluation which would decrease current account surplus- GDP by 4% and using the 17 sector computable general equilibrium model.

The author wants to figure out if this realignment of the Yuan is in its own self-interest as some internal and external voices have suggested or if this will ultimately lead to China short-changing itself. The author provides sufficient info on the background of China's current account from 1990 until 2004.

The author employs the comparative static computable equilibrium model. The model makes a distinction of 17 industries (agriculture ,electricity ,construction etc.) and the two sectorial important factors of production labour and capital.the author is able to explain how the models are used and why the particular variables instituted are used. He also manages to test whether Goldsteins assumption that a drop in current account/Y ration by 4% would re-establish op equilibrium.

The conclusion from the simulation shows that re-aligning the Yuan would actually increase the Employment. This will be due to that the strong Yuan will cause supply sterilization of bonds. This would lead to a drop in rates of borrowing thus spending and investment would increase.

The author structured their argument well and truly answered the question by finding supporting evidence.

Investment Implication of Future Chinese Yuan Revaluation

JH Davis

The aim of this paper is to figure out through model based estimators what the potential impact of revaluation for US investors would be. This method is often used to identify statistical dynamic interactions in an equilibrium system. The author used vector auto regression. The variables employed were Broad trade, Import price index, PPI, CPI, Producer Price Index for crude material, Producer Price Index for intermediate goods. Other control variables were capacity utilization rate, linear time trend, and capacity utilization rate, current and lagged percentage change in crude oil prices. Data was gathered monthly from September 1989 to December 2003.What was concluded is that a revaluation of the Yuan dramatically would cause very little inflation thus the effect on bonds and US stocks would be very minimal.

With a weaker Yuan the Central bank of China would have less influence in the US treasury market. Thus fixed income investors wouldn't be highly affected. In the end the author concludes that it will be honestly difficult to predict the after effects of revaluation but that the best protection for investors is diversification.

Winners and Losers: Assessing the impact of Chinese Yuan appreciation

Jian Zhang, Hung-Gay Fung

This paper was done to figure out the effects of the Chinese appreciation on consumption, investment, trade, output and welfare of other nations in different parts of the world. It employs the computational general equilibrium model to do so. A static multiregional computational general equilibrium model was gained from modifying the GTAP model. 12 regions and 57 sectors (which are grouped into five major one : energy, agriculture, minerals, skilled manufacturing , unskilled manufacturing) are aggregated . the conclusion is that there would be a greater effect in the short run rather than in the long run as the EU and Canada will make the greatest gains in the short run causing an income distribution in different regions. The revaluation won't reduce the US deficit because even though the Yuan will go up , the US will still purchase from either China or other countries that provide the same products at cheaper prices. The effect in China will be bad as the will be inflation and interest rates will go down.

Revaluation of Chinese Yuan and triad trade : A gravity assessment

Miaoje Yu

The aim of this paper is to figure out the causality effect between exchange rates and the bilateral trade between China Japan and the US , this is done using data from q1 2002 to q4 2007 for all the nations. The gravity model is used to figure this Previous studies had paid little attention to the two way causality but this paper went further in its efforts to do this. The variables are imports, exports, PPI, GDP. The final assessment is that the revaluation will have an effect on the amount of trade between China and the US but because the Yen and Yuan always had a floating exchange rate it will cause no significant change in the current amount of exports from China to Japan. In the long run the deficit between China and the US may rise again because of an over consuming approach by the US and an over saving approach by the Chinese. The author argument was well structured and he was able to connect the manner in which they went about the study with what they were actually trying to figure out.

China's exchange rate policy and the United States' trade deficits

AS SOOFI

This purpose of this study is to scrutinize China's exchange rate strategy issue and have recourse on its financial and capital manipulation change of current times. On top of which, employing the empirical outcomes founded on a regional general equilibrium model, other methods are recommended of speaking on US fears about China's part in backing towards global financial steadiness and American trade shortfalls with China.The methods used for observing this study was the Regional general equilibrium input-output model.

What was discovered in the end was that China-US conflict on exchange rate regime is a matter of alteration of opinion in terms of how china has decided to conduct its policies on foreign exchange to help boost its trade deficits. It is noted that what China decides to do with its foreign exchange greatly affects the American exports to an extent.The models shortcomings are that it fails to look at other economies in the world ..

What this paper implies is that as China will unlikely revalue its currencu to levels that the US feel are satisfactory, other methods of reducing the trade deficit may have to be sought. This research implies a fresh, empirical-based policy endorsement in addressing the American trade deficit with the Chinese.

Excess Liquidity, Inflation and the Yuan Appreciation: What Can China Learn from Recent History?

C Zhang

This reports looks at the concerns of too much liquidity, inflation and the revaluation of the Yuan occurring at present in the People's Republic of China. The author tracks the relationship between over liquidity and the rise in general prices. A dynamic model is also employed.

The data gathered spans from the first quarter of 1998 till the last quarter of 2007. The author feels that it is astonishing that such little study has been steered into the possible correlation between excess liquidity and inflation in China. The variables are CPI, M2, and NGDP.

Overall, the empirical outcomes in this section indicate that excess liquidity in China contributes significantly in making consumer price inflation during the period 1998-2007.What the author then comes to learn is that international capital inflows, excess liquidity and inflation in China are all linked to the Yuan exchange rate appreciation. This shows that China should not make drastic appreciation to its currency as this will alternately cause huge shift to all these other factors. Thus it is advisable China continue in its steady revaluation

Topic

Author

Variables

Method

Conclusion

Economic Impact of the Chinese Yuan revaluation

Zhang Xiaohe

GDP, inflation, consumption, investment, export, import and employment.

the multi-country econometric model (MCU) created by Ray Fair. "

revaluation of the Yuan would affect the Chinese economy as well as the global economy to some extent

The Impact of Yuan Revaluation on the Asian region

Glenn Hoggarth and Hui Tong

Imports, exports, GDP

panel data analysis

countries that supply consumer goods to third party countries and china wil have boost in their exports and for those that supply high end good to china there will be a slump.

Impact of China Yuan Revaluation

William Pan

Imports, exports ,ER

Qualitative analysis

the revaluation would create less of a trade deficit between the us and china

The Yuan's Exchange Rates and Pass-through Effects on the Prices of Japanese and US Imports

.

Xing, Yuqing

were imports, exports, marginal costs, unit labor costs, PPI, CPI

Pass through effect

No pass through effect of Yuan revaluation on Japan import prices from the us import prices

China's Economy after the Currency Revaluation-Policy Management Implications and the Effect on Domestic and Foreign Economies

Sayuri Ito

CPI, exchange rate, import ,export, GDP

Analyzing trend

reform will have a limited impact on domestic and foreign economies in the near term, by reducing chinese exports and reducing us imports. China may benefit in the end.

Investment Implication of Future Chinese Yuan Revaluation

JH Davis

Broad trade, Import price index, PPI, CPI, Producer Price Index for crude material, Producer Price Index for intermediate goods

VAR

A weaker Yuan the Central bank of China would have less influence in the US treasury market. Thus fixed income investors wouldn't be highly affected

The Effects of Revaluating the Yuan on Stock Markets

Geungu Yu

S&P 500 , SSE

Exchange rates

No models or empirical model

connection among yield spread fluctuations and performance of differing styles of investing, this implies that yield spread shifts could be sufficient indications for choosing between growth vs. value stocks.

Structural effects of Real Exchange Rate Revaluation on China

Dirk Willenbockel

The model makes a distinction of 17 industrie (agriculture

,electricity

,construction etc.) and the two sectorial important factors of production labor and capital

17-sector computable general equilibrium model

conclusion from the simulation shows that re-aligning the Yuan would actually increase the Employment

Winners and Losers: Assessing the impact of Chinese Yuan appreciation

Jian Zhang, Hung-Gay Fung

consumption, investment, trade, output and welfare

static multiregional computational general equilibrium model

greater effect in the short run rather than in the long run as the EU and Canada gain in short run causing an income distribution.US deficit wont necessarily reduce

Revaluation of Chinese Yuan and triad trade : A gravity assessment

Miaoje Yu

imports, exports, PPI, GDP

The gravity model

revaluation will have an effect on trade between China - US but because the Yen and Yuan always had a floating exchange rate it will cause no significant change in the current amount of exports from china

China's exchange rate policy and the United States' trade deficits

AS Soofi

Exports and imports

Regional general equilibrium input-output model

what China decides to do with its foreign exchange greatly affects the American exports to an extent.

Excess Liquidity, Inflation and the Yuan Appreciation: What Can China Learn from Recent History?

C Zhang

CPI, M2, and NGDP.

A dynamic model

international capital inflows, excess liquidity and inflation in China are all linked to the Yuan exchange rate appreciation. This shows that China should not make drastic appreciation to its currency as this will alternately cause huge shift to all these other factors.

Impacts of Monetary, Fiscal and Exchange Rate

Policies on Output in China: A Var Approach

YU HSING1 and WEN-JEN HSIEH

Inflation, employment,

Government spending

Money supply

VAR model

the

government may consider conducting monetary and fiscal policies differently in the short run

and long run.

Because output reacts differently in both cases.

The most commonly used variables are GDP, imports, exports, and BOP. The most used Method is the VAR model. What the conclusions often are is that the Yuan if revaluated will cause China's economy to be less competitive thus making them export less and causing their GDP to shrink. It is also assumed that this will lead to exports of nations like Japan reducing and as well as exports of nations that produce products similar to those of China increasing.

CHAPTER 3: METHODOLOGY

The section is concerned with developing and applying quantitative and statistical methods to the study.

Methods:

Literature review:

By looking at past literature reviews which tries to tackle the same topics

Quantitative analysis:

Looking at what happened to China and the specific other countries when last the Yuan was revaluated

Panel data analysis:

Pools countries together and increases the sample size significantly than if I was using . Bilateral export and import equations are estimated for the Asian countries.

With Three related empirical models are examined: China's own exports, China's imports, and the competition between Asian countries and China in third markets.

For china's exports:

Δln (Ex China )= Δln(Ex China t-1)+ Δln(china R)+ Δln(China Gdp)

For China Imports

Δln(exports of ..) = Δln(china gdp) + Δln(exports from ..)+ Δln(commodity structure of country..)+ Δln(exports vs importer ex-r)+ Δln(GDP of country...)

Exports of other asian nations to 3rd party states

Δln(exports of ..) = Δln(exports from ..)+ Δln(commodity structure of country..)+ Δln(China exr)+ Δln(GDP of country...)

Sources of Data

The study utilizes secondary data obtained from the IMF's International Financial Statistics. The empirical analysis uses yearly data from 1999 to 2009 of GDP, EXPORTS AND IMPORTS and EXCHANGE RATE. The data covers this period to look into the trend of the current situation of what happened to the economies when the currency was revalued.

Estimation Methods

 Unit Root Analysis

After picking the model, the right unit root analysis should be used. Given that the data is trended, Unit Root test is used to determine if the series is consistent with a I(1) process with a stochastic trend, or if it is consistent with an I (0) process, whereby it would be stationary, with a deterministic trend.

The Augmented Dickey Fuller test is used to test the order of integration of the variables. The variables would be tested using Augmented Dickey Fuller in its number of forms that is tested for first with a stochastic trend and without trend at both at level and at 1st difference to determine its stationary. Given that the data is not stationary at level, it would have to be tested at 1st difference. If the value of δ is 0 it concludes that the data is stationary.

Augmented Dickey Fuller hypothesis

Null hypothesis: Unit root (Not stationary)

Alternative: Stationary

If the calculated absolute worth of the tau statistics exceeds the DF or MacKinnon critical tau values, we reject the null hypothesis that is δ=0 meaning that data is stationary. alternatively, if the absolute value of the tau statistics is not over the critical tau value, we cannot reject the null concluding that data is non-stationary or random walk. The data has to be non-stationary at level in order to move on to other test, which is the cointegration test. The Akaike's information criterion (AIC) is used to determine the optimal lag length.

 Cointegration Test

The cointegration test is utilized after the unit rot test. In this situation, we use Johansen Cointegration test given that it's more advantageous than Engle-Granger in testing for long-run relationship among variables. It is unbiased and more efficient. It's utilized because it assists to avoid spurious regression. The trace and the maximum eigenvalue test are used to determine the number of co-integration vectors. The max eigenvalue is better in this situation. Co-integration hypothesis

Null hypothesis: There is no cointegration

Alternative: There is cointegration

When co-integrated variables appear we should go for error correction mechanism (ECM), which is in essence a model that allows long-run components of variables to abide by equilibrium constraints while short-run components have a flexible dynamic specification. correcting disequilibrium is the objective.

 Hypothesis Testing

testing about individual regression coefficients is the main drive of this part. The t test is used to conclude if there is sufficient proof of a linear relationship amid each independent variable and the dependent variable.

T test hypothesis

H0: a 1=0

H1: a 1¹0

There is a contrast between the critical t value and the computed t value for the sole purpose of testing the hypothesis. If the calculated t value exceeds the critical t value at the level chosen of significance, the null hypothesis is rejected and if not, we are unable reject the null.